The Kaesong Industrial Complex: Setting the Stage for a Successful Second Act

This article draws from research conducted in the preparation of International Crisis Group’s recent report, “The Case for Kaesong: Fostering Korean Peace through Economic Ties.”

The Kaesong Industrial Complex was once at the heart of South Korea’s pro-rapprochement “sunshine policy.” Launched in 2004, Seoul hoped that this joint economic initiative might help pave the way toward a brighter and more stable future for the peninsula. It shelved those hopes in 2016, when President Park Geun-hye closed the complex following Pyongyang’s fourth nuclear test, and amidst perceptions that North Korea profited from Kaesong at the expense of South Korean taxpayers and North Korean workers. But those perceptions are off base in one important respect: Our newly published research shows that South Korean firms prospered much more at Kaesong than is commonly known. While reopening Kaesong would primarily be a concession to the North—which could usefully be exchanged for a proportionate step toward denuclearization by North Korea in order to help stalled peace talks get back on track—the South has reason to be excited about it as well. In order to maximize the opportunity, however, it will be important to address concerns about worker exploitation and operational inefficiency that impeded the complex in its last incarnation.

A Win-Win Arrangement

The concept of Kaesong as articulated two decades ago was sound. A manufacturing zone in the North would play host to a diverse array of South Korean firms. The North would provide land and labor and the South would furnish capital, infrastructure, technology and materials. Thus, one of the poorest countries on Earth could materially benefit from its location next door to an advanced industrial economy—and vice versa. Built by an arm of the giant Hyundai conglomerate, Kaesong offered the prospect of potentially thousands of South Korean small- and medium-sized enterprises helping to grow and, in the process, rebuild the economies of both the North, which was just emerging from a decade of ruinous decline, and the South, which was on the path back to prosperity following the 1997 Asian financial crisis.

The North had the most to gain from this arrangement. While reliable economic data are hard to come by, our interviews with hundreds of defector-migrants indicate that North Koreans viewed Kaesong as the best place to work in the country. They received health care, child care and other services at a level uncommon even in South Korean small and medium firms, much less North Korean enterprises. More important in Pyongyang’s eyes, however, was the hard currency flowing into its coffers. Because the firms paid North Korean salaries, and because those payments went to the State rather than the workers—who were compensated through in-kind staple deliveries, state store coupons, and domestic currency—cash-strapped Pyongyang netted non-negligible sums through this arrangement (perhaps exceeding $100 million annually at the peak of Kaesong’s operations).

But the South benefited from Kaesong too, with South Korean firms profiting far more than is commonly understood. Indeed, our new report for the International Crisis Group shows that South Korean firms operating in Kaesong (many of them small- or mid-sized clothing manufacturers) saw their profits rise by an annual average of 11 percent between 2007 and 2014, their revenues increase by 8 percent and the value of their fixed assets grow by 26 percent. These figures are all the more impressive when compared to data for non-Kaesong firms operating in comparable sectors of the South Korean economy. In those seven years, the number of firms manufacturing in the apparel, fashion accessory, leather goods and shoe industries shrank by a staggering 65 percent. Some firms stayed in business by taking production offshore to Vietnam, China or Myanmar, but these generally did not see gains like those that set up shop in Kaesong.

Still, however much Kaesong’s upsides may be underappreciated, the venture fell well short of its creators’ aspirations. While their original plan had envisioned the complex enlarging in a series of stages into a global manufacturing hub, the project never grew to even its full first-stage size. After Pyongyang’s first nuclear test in October 2006, the South essentially froze and ultimately abandoned plans to expand the complex.

Also put on hold were South Korean efforts to get the North to allow payments to flow directly to workers, who might have used the resources to stimulate economic growth beyond the complex fence. But Pyongyang demurred, the Ministry of Unification stopped pushing, and the impression began to take hold in the South that North Korea’s central government profited from Kaesong at the expense of both South Korean taxpayers and North Korean workers and was diverting its gains to fund illicit weapons programs. For better or worse, few in the South shed tears when the complex closed in 2016.

A Second Act?

Our research tells us that Kaesong merits a second act, but setting the stage will take some doing. For one thing, UN Security Council sanctions imposed on North Korea in response to its nuclear and missile activities currently prohibit the project’s revival. For another thing, Seoul would have to build domestic political support with a public that continues to have some misgivings about Kaesong from its first period of operations, and opposition parties that have seized upon concerns about any South Korean initiatives that could be seen as bucking the international sanctions regime.

One way that might help the two Koreas move past the sanctions hurdle—while at the same time helping to stimulate stalled peace talks between North Korean leader Kim Jong Un and US President Donald Trump—would be to make reopening Kaesong part of a modest, momentum-generating deal that the two countries could announce at a third summit (should one occur) or other appropriate occasion. As Crisis Group has written elsewhere, the reopening of the complex in return for the verified closure of nuclear facilities at Yongbyon in North Korea could be the core of such a deal, which might also be sweetened by reopening South-North tourism at Mt. Kumgang, the proffer of an end-of-war declaration by the United States, and other measures of similar scale. The visit of Chinese leader Xi Jinping to Pyongyang last week and recent exchange of letters between Washington and Pyongyang hints at another surge of diplomatic activity on the horizon. The time to begin actively exploring such a deal could be at hand.

Setting the Stage for Success

As for winning over the South Korean public, the analysis we present in our report suggests that Seoul should have a good story to tell about the benefits for South Korean businesses, and that’s just part of the picture. If permitted to reach its potential, a reopened Kaesong could provide enhanced economic benefits to both Koreas, and become a force for promoting more stable, peaceful coexistence between the two Koreas. To maximize the gains to both sides, however, it will be important to address the flaws that bedeviled the complex in its original form.

First, it will be necessary to improve the efficiency of North Korean regulations on internet use, telephony, the hiring and management of workers, and customs that made Kaesong such an atypical special economic zone. Seoul and Washington should press Pyongyang to agree to internet and cellular telephone use within the complex, even if only on a restricted basis. They should also streamline and standardize the customs and border crossing procedures.

Second, while Pyongyang may be reluctant to relinquish control, Seoul and Washington should press it to yield partial responsibility for hiring and wage decisions over North Korean workers so that South Korean firms can manage them more efficiently. Both governments should stress with Pyongyang that these are not political matters, but rather good business practices that will help attract a stronger group of firms to Kaesong. In addition, workers should be allowed to live within the complex, so that firms will know they have enough on hand to meet production needs and are not driven to over hire or “hoard” workers, as they used to do, because they did not know whether or when they would get more.

Third, and perhaps most important, Washington and Seoul should seek flexibility for firms to make at least a portion of wage payments directly to workers, thereby mitigating (though not eliminating) worries among possible investors over worker exploitation and about the diversion by Pyongyang of hard currency toward illicit ends.

Conclusion

These goals will not all be achievable. But with patient negotiation by Seoul, Washington, and the firms that hope to operate at Kaesong, some progress may be possible, and any gains would make Kaesong a stronger, fairer, better place to do business. Such improvements can in turn help the complex not only resume making money but also create momentum for the Korean peace process—just as its architects intended.